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Reform by the ounce, unfunded pension debt by the pound

The pension reforms passed in June, paring back the benefits for new teachers and administrators, will knock off $189 million per year from the additional payments taxpayers must make to keep the California State Teachers’ Retirement System solvent over the next 30 years.

The market value of CalSTRS’ assets remains below the high in 2007. Retirement benefits for members assume a rate of return on CalSTRS’ investments of 7.5 percent annually. Because the defined benefit plan has fallen behind, without growth from compounded interest, the unfunded liability – required to keep the system solvent for the next 30 years – is now $65 billion. (Click to enlarge).

That’s the good news. The bad news is that this represents only about 6 percent of the extra $3.25 billion annually that CalSTRS actuaries are saying is needed to erase the system’s current $65 billion unfunded liability. That liability is the debt that taxpayers owe to future pensioners to compensate for shortfalls in CalSTRS’ income on investments following the Wall Street implosion in 2008. CalSTRS is still recovering from that with $152 billion in assets in July, still $20 billion below a high of $172 billion in 2007.

The Legislature hasn’t yet started paying down that liability, and it isn’t expected to until 2016 at the earliest, given the precarious state of the budget. But when it does start making a dent in the $65 billion, it will be diverting money that otherwise could go to restore funding for K-12 and community college programs.

Legislators had only a crude estimate of the financial impact of the pension reforms they passed in the final day of the session last month. The deal that legislative leaders and Gov. Jerry Brown cut didn’t leave enough time for the state’s two largest pension system – CalSTRS and CalPERS, the California Public Employee Retirement System – to do the math in time; they barely knew what was in it.

CalSTRS completed its analysis last week. It showed that the changes, in lowered benefits and higher employee contributions, will ease the pressure on the system. But it will take decades for the full impact to take effect, because the reforms will apply only to employees hired after Jan. 1, 2013. Courts have ruled that pension benefits for public employees are a vested right that can’t be undone unless employees are given something of comparable value in return, like a raise. Legislative leaders and Brown didn’t challenge that assumption in coming up with a pension deal.

Through concerted effort and rising values on Wall Street, CalSTRS’ defined benefit program became more than fully funded by 2000. A combination of new benefits followed by a plunge in investment values in 2007-08 has left it only about 70 percent funded; anything below 80 percent is a serious problem. Source: 2011 Actuarial Evaluation by the firm Milliman for CalSTRS. (Click to enlarge)

The CalSTRS analysis concluded that CalSTRS will save $22.7 billion over the next 30 years (about $12 billion if adjusted for inflation) through paying out lower benefits, though most of the savings will years from now when new employees retire.

Most of that will be achieved by raising the retirement age by two years for the same level of benefits. CalSTRS’ 430,000 active members are currently retiring on average at age 62, with 25 years of experience, for which they’re entitled to receive a benefit equal to 56 percent of their highest-year salary, about $4,000 a month on average. Future employees who retire at the same age will get 6 percentage points less: 50 percent of the average salary.

The reforms also restrict double-dipping (turning around and returning to work as a teacher or principal after retiring), and they ban pension spiking (getting a big raise in the final year of work to build up a big pension). Pensions will be determined on the average of three consecutive years of the highest pay, not the final year. And there will be an inflation-adjusted maximum income – $136,440 in 2013 – on which pensions will be based; those who earn more than that – superintendents, some administrators, and principals in a few districts – won’t get a higher pension. CalSTRS says that provision will affect only 3,400 employees, less than 1 percent of active members.

Teachers and administrators, their school districts, and the state (through the General Fund) pay into CalSTRS. The combined contribution rate is currently 18.51 percent of each employee’s pay, with the employee contributing 8 percent, the district paying 8.25 percent, and the state paying 2.26 percent. The reduced payout in benefits will eventually reduce the “normal” costs to 15.9 percent of payroll, with the savings going to the state and districts (how the savings will be split between the two isn’t clear under the new law). Employees will continue to contribute 8 percent of their pay into CalSTRS.

Last April, actuaries estimated that paying off CalSTRS’ $65 billion in unfunded liability would require raising the level of contribution an additional 12.9 percentage points, to nearly a third of an employee’s pay. That would require $3.25 billion more from the General Fund for CalSTRS alone. As a result of the passage of AB 430, the pension reform bill, the reduced benefits will offset three-quarters of 1 percentage point of the increase: $188.5 million less from taxpayers.

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21 Responses to “Reform by the ounce, unfunded pension debt by the pound”

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Gary Ravanion Oct 1, 2012 at 2:08 pm10/1/2012 2:08 pm

000

You know, John, finding the appropriate Wall Street parties guilty, when they were/are guilty, is something called justice. That’s like “with liberty and justice for all,” kind of justice. And when that is accomplished fines can be levied. Those “too big to fail” are now pocketing bonuses and piling up cash reserves that rightly should be going to a fund to redistribute those ill-gotten gains where they will do some good.

And yes, let’s pull STRS out of the scrum when it comes to highly enhanced pensions, and then how about the vast majority of state PERS pensions while we’re at it. There are some municipalities that are struggling, but wait, many/most of their problems are traceable to the housing crash that leads right back to…Wall Street. Where it isn’t traceable to housing its traceable to poor decision making by electeds and then compounded by some phony investment instruments “sold” to local governments as a way of side-stepping immediate tax increases. CA’s low taxes relative to high cost of living are partially to blame, but much is also traceable back to…Wall Street.

Yikes! Do I perceive a pattern developing here?

New employees, under the conditions of the pension “reform,” have been thrown under the bus. Applications to teacher credentialing programs have fallen off by about 50% in the last few years, the number of boomers retiring is accelerating, and there is a looming teacher shortage on the near horizon. Think the new pension rules are a real incentive for new candidates to join the ranks?

Gary Ravanion Sep 26, 2012 at 1:07 pm09/26/2012 1:07 pm

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I think it only makes sense that when the underfunding of PERS and STRS was caused by the greed and fraud of Wall Street that common everyday teachers, police and firemen should have to suffer because of it. Why Ayn Rand, not to mention various Robber Barons of days of yore, would be proud to oversee such a system. After all, who should suffer for the malfeasance and misfeasance of the banking and financial sector? Bankers and hedge-fund guys? Please, let’s get real.

Since PERS and STRS calculate their funding based on average investment earnings created over the course of decades let’s take that the snapshot of their fiscal well-being today, while in the trough of one of the biggest investment “crashes” in two lifetimes. That too makes perfect sense.

Secure retirements for the middle-class are the stuff of dreams. After all, how could the cumulative wealth of the top 400 people in America (according to Forbes) increase by $200 billion, last year during the recession, if some of those dollars were spread around to all of those pesky working people with increases in salaries, benefits, and retirements? I ask ya’ that?

John Fensterwaldon Sep 28, 2012 at 3:33 pm09/28/2012 3:33 pm

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You can’t have it both ways, Gary. in the late ’90s tech boom, when it appeared stock prices would rise forever (I interviewed author James Glassman of Dow 36,000, who was taken quite seriously at the time), public employee unions were successfully pitching substantial increases in benefits and pension holidays (less so at CalSTRS, for sure). We all know how that turned out.
I’d like to see a lot more prosecutions for the investment banking/mortgage debacle. But railing at Wall Street won’t solve the actuarial problem CalSTRS now faces. Additional money that should go to operations of schools will fill in the gap from a failure to make the 7.5 percent annual return on CalSTRS investments (just lowered from 7.75 percent). Not just taxpayers but also the next generation of teachers will bear the burden.

navigioon Sep 28, 2012 at 3:51 pm09/28/2012 3:51 pm

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I do think it’s fair to try to clarify where blame should be laid. Not because that is inherently a productive thing (usually just the opposite), but because it will avoid having the wrong people pay for it. In reality, society was fleeced by wall street, and the impact of that cannot be ignored. This resulted in the public actually approving (directly or indirectly) most of the steps that have led to the current situation (as you point out, glassman was taken quite seriously). I believe our entire society shares the blame for the situation we are in, and anyone who believes in personal responsibility should believe that that means our entire society shares the burden for rectifying the situation. In any case, our teachers and our children are not the cause of our fiscal problems!

jskdnon Sep 25, 2012 at 12:17 pm09/25/2012 12:17 pm

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I’m guess I’m confused. I thought that the unfunded actuarial accrued liability was difference between the actuarial accrued liability and the actuarial value of the fund’s assets. I assumed that unfunded liability of benefits earned to date is expressed in present value dollars, so that CalStrs would need to have $65 billion more in assets on hand right now in order to be able to meet pension obligations that come from employment that has already been completed, that is not counting the pension obligations that will accrue from employment going forward. Furthermore I thought the present value is determined by discounting by the assumed rate of return, 7.5% annually in the case of CalStrs. But if the fund is $65 billion short, wouldn’t those assets that aren’t there also be subject to that 7.5% rate of return, thereby growing by that amount compounded every year? A 7.5% return on $65 billion is $4.875 billion for just one year, not earned from assets that aren’t there and therefore added to the unfunded liability. And that would be an interest only cost. The cost of amortizing the $65 billion liability away through contributions over 30 years at 7.5% would be higher, around $5 ½ billion a year. $189 million a year is only about 3 ½ %, not 6% of that amount.

If I am misunderstanding this, I’d like it if someone would direct me to a source that could demonstrate what is right.

John Fensterwaldon Sep 25, 2012 at 2:23 pm09/25/2012 2:23 pm

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Dear jskdsn,
I referred your question to a CalSTRS official, who didn’t know how you calculated the $5.5 billion figure but suggested you may have neglected to factor in the growth in payroll over 30 years against which the higher contribution rate would be imposed and suggested you look at Table 16 on page 46 of the 2011 actuarial valuation by Milliman. The link is toward the bottom of the page here.

jskdnon Sep 25, 2012 at 6:46 pm09/25/2012 6:46 pm

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John- that link doesn’t work.

I got to the $5.5 billion by putting $65 billion into a mortgage calculator using a 7.5% interest rate (equal to the CalStrs discount rate used to measure the adequacy of its assets) and a 30-year amortization (the same period used for the projected savings). That produced $454 million month or $5.45 billion a year.

I don’t see how the growth of payroll and the higher contribution rate should matter unless those contributions are in excess of the what is necessary to adequate fund the additional pension obligations that will accrue going forward from this point. I believe unfunded liability is for pension obligation that are already earned, that is for employment already completed. If my calculations and understanding of how it works are correct and the contributions that will be made going forward are sufficient to fund the new obligations, and CalStrs can earn the average return of 7.5% on their assets that they assume, then retiring the unfunded liability over 30 years would take an additional $5.45 billion a year more than those contributions need to fund new earned benefits. A least that’s how I’m figuring it.

John Fensterwaldon Sep 25, 2012 at 8:45 pm09/25/2012 8:45 pm

000

Sorry about the bad link, jskdn.http://www.calstrs.com/Help/forms_publications/pubs.aspx
Go to the section:
Financial Reports, Actuarial Valuations, Investor Information
It’s the first .pdf listed.
I don’t have the knowledge to comment on your calculations. Perhaps another ready can.

jskdnon Sep 26, 2012 at 10:55 am09/26/2012 10:55 am

000

The first pdf under “Financial Reports, Actuarial Valuations, Investor Information” was “Comprehensive Annual Financial Report–2011”. It was interesting but I couldn’t find that which addressed my point. But below that was “Defined Benefit Program, Actuarial Valuation as of June 30, 2011.”

It seems to confirm how I’ve been thinking about this. On page 44 is a chart called “Amortization of Unfunded Actuarial Obligations.” It might have better been called “Negative Amortization of Unfunded Actuarial Obligations.” While under the scenario in the chart the state does contribute more than the costs of funding additional benefits that accrue (the normal cost), that amount is miniscule. So, as I noted in my first post, the failure to make payments that would cover the interest let alone actually amortize it, cause the unfunded liability to grow at a compound rate. The amortization cost this year is more than the normal cost for newly accruing benefits this year. Next year the interest only cost of the unfunded obligations equals the normal costs, and then rapidly becomes more than the normal costs. The compounded growth of the current unfunded obligation of $65 billion runs it up to $550 billion in year 30.

Tough Loveon Sep 25, 2012 at 10:59 am09/25/2012 10:59 am

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Quoting …”Last April, actuaries estimated that paying off CalSTRS’ $65 billion in unfunded liability would require raising the level of contribution an additional 12.9 percentage points, to nearly a third of an employee’s pay. ”

Which means that if the CalPERS “official” estimate of it’s unfunded liability of $65 Billion is really about $150-$200 Billion as most financial economists estimate, then than that INCREMENT of $12.9% of pay rises to about $30% with the total contribution going to about 50% of pay.

SURE … not a problem …. Taxpayers will pay for it. LOL

Robert Mitchellon Sep 25, 2012 at 10:22 am09/25/2012 10:22 am

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Much has been said. Little has been done. Major pension costs are still being pushed down the road, and the CalSTRS actuaries are still not telling the whole truth. Show us every year how much the pension benefits actually cost in real market terms. Charge each agency for at least the value of the benefits earned that year, or at least tell us how much they didn’t pay.
Have the legislature change the funding to normal rules.
Everything else is just game-playing.

Tia Parisiteon Sep 25, 2012 at 8:15 am09/25/2012 8:15 am

000

Let’s talk pensions, pensions only amount to 3% of the State of California’s budget, http://www.letstalkpensions.com/myths-and-facts employees pay into this benefit through payroll deductions. Yet you are attacking the 3% and not responded to the 97% elephant in the room.

edfundwonkon Sep 25, 2012 at 2:12 pm09/25/2012 2:12 pm

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Thanks for sharing this publication shilling for the CTA. How about something from a legitimate neutral source?

@capsaysunon Sep 25, 2012 at 5:25 pm09/25/2012 5:25 pm

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That 3% figure is bogus. That’s the amount the state pays just to CalPERS, just to keep the current pension system solvent. It also ignores the tens of billions the local governments have left unfunded. Pretending the problem isn’t real won’t make it go away.

eatingdogfoodon Sep 25, 2012 at 6:20 am09/25/2012 6:20 am

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RICO Conspiracy; The Unions and the Democrats!

Paul Muenchon Sep 25, 2012 at 6:05 am09/25/2012 6:05 am

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We should stop borrowing money from teachers and go to a defined contribution plan instead of a defined benefit plan. The American economy is not stable enough to make defined benefit plans predictable on both sides, payor and beneficiary.

navigioon Sep 25, 2012 at 12:59 pm09/25/2012 12:59 pm

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IMHO, we dont have enough money (or political will) to pay the increase in teacher salaries this would require. Let alone the government services and funding that will be needed when the estimated 90% or more of 401k holders retire into poverty.

Paul Muenchon Sep 25, 2012 at 10:02 pm09/25/2012 10:02 pm

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Not clear that CA won’t default on the existing plan either.

navigioon Sep 26, 2012 at 1:17 am09/26/2012 1:17 am

000

Touché.

And yes, the further we get into this, the more I think that might actually be the ‘plan’..

navigioon Sep 25, 2012 at 1:16 pm09/25/2012 1:16 pm

@capsaysunon Sep 25, 2012 at 5:35 am09/25/2012 5:35 am

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The last-minute pension bill does nearly nothing; it’s not even a seven percent solution. Just a ploy from the governor to trick you into voting for his tax plan. We won’t see any real reforms until we get special interest money out of politics.